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'Financials need a steepening yield curve': Richard Bernstein

Richard Bernstein of Richard Bernstein Advisors joined Yahoo Finance to discuss his outlook for the market into 2021 and his thoughts on how the election may impact the market.

Video Transcript

MYLES UDLAND: Rich, great to have you on the program. I-- I read your latest note, and I'm just curious how you would sort of summarize the highest level takeaway there. Because there's a couple really interesting dynamics, I think, for the next several years investors might be surprised showed up in-- in your work there.

RICHARD BERNSTEIN: Yeah, I think, Myles, I-- I think that, look, if you-- the technology sector has had a huge run. Everybody knows that. And we've got what's-- what I would call the Fab Five stocks, right? Basically five or six companies that everybody knows. I don't think that people understand fully, though, what it-- what their implied economic forecast is if they're investing in those stocks today or they're holding those stocks today.

Basically, what history shows is that when profitability slows down, markets become very Darwinistic. It becomes survival of the fittest. And the biggest and the best kind of get bid up, and leadership becomes very, very narrow within the marketplace. So if you think about what's gone on in the past couple years, that makes perfect sense, right? Profitability has been waning. That-- that was just-- profitability was destroyed in the pandemic. And so what we've had is the Fab Five. Makes perfect sense.

But if you're besting them today, you're basically saying for the next 12 months and the next 24 months there is no company anywhere in the world that's going to grow. That is immensely bearish, and I don't think people understand that. They-- when-- when profit cycles turn when the economy recovers, you get very broad leadership, not narrow leadership.

MYLES UDLAND: And-- and I think that kind of is part of the thesis with the beginning of a profit cycle is essentially positive for value. All else equal, I-- I guess we could say. But is that a fair way to say it? And then I'm sure you get pushback on this thesis from clients who have done quite well buying all of these names. I mean, how-- how do you navigate that sort of conversation as well?

RICHARD BERNSTEIN: Right. Well, you have to remember the number one factor-- listen, many academics have studied this. The number one factor that determines if something-- if the stock is attractive is an upward sloping price chart, right? Just because it goes up, people say it's got to be good. If it's going down, it has to be bad. So we have to remember that point. But I think what people say is, well, you don't understand, Rich. These are the secular growers. These are the dominant companies. And that may well be true. I'm skeptical of that, but maybe that's true.

However, what history, again, shows very clearly is that cycles always get in the way of a secular story. So, you know, the Fab Five may be growing earnings 25%, 30%, 40%. What people forget is that cyclical stocks, when the cycle turns, they grow their earnings 100%, 200%, 300%, 400%. And the market re-values that 100%, 200%, 300%, 400% until it stops. And then you go back to the safe haven type stocks again.

MYLES UDLAND: And so as you look at, you know, S&P sectors right now, and-- and I think the ones that have been left behind more than any would be energy and-- and financials, that's where you have a lot of passionate disagreement around where those sectors should go. And I think there's some idiosyncratic stories there. But if we just look at financials, per se, right, the old "it's a levered bet on the economic cycle," it would seem that that kind of the backdrop of, well, they'll have more stimulus. We're at the beginning of the cycle. Should, again, be positive for this, though. This is still-- they haven't really been able to get momentum going.

RICHARD BERNSTEIN: Absolutely. And here's the monkey wrench to the traditional analysis for financials. That is what financials need is a steepening yield curve. You want to see long-term rates go up relative to short-term rates. That's effectively a proxy for the lending margins of a financial institution. Well, what's the Fed been doing? The Fed has been flattening the long end of the yield curve. They're buying bonds and flattening the long end of the yield curve. So that stymied the profitability of the large financial institutions.

It's actually quite-- quite odd that the Federal Reserve would be doing this and basically disintermediating the private sector banking system. You'd think they'd want to stimulate the private sector banking system. They're doing the exact opposite, whether they realize that or not. The odd thing here is the Fed's own research shows that a steeper yield curve is better for lending and better for the economy. And what's the Fed doing? They're flattening the curve. You got me on this one.

MYLES UDLAND: Yeah, well, I think a decade of knowing how to flatten it has certainly created a lot of institutional inertia there. Quickly before we let you go, I'd be remiss if I didn't ask you about what's happened with gold this year. It's been an eventful year for gold. You know, going back to-- to April, I know you said you had a-- a nice position in gold. What-- what have you kind of done there?

RICHARD BERNSTEIN: No, we are still in gold. In our biggest portfolios, it's about 6% to 8%. You know, look, the only certainty about 2021 is that there's going to be continued uncertainty. That's the only thing we can say with any certainty. And gold, historically, has been a very good hedge against uncertainty. And if you look at when uncertainty started really to pop up in all the measurements, it was in 2015, 2016. That's when gold troughed. So if you think we're still going to be in an uncertain environment, I would argue it's worthwhile to have gold in the portfolio as a balance-- ballast against that uncertainty.